The voices of Urban Institute's researchers and staff
May 31, 2011

Drop Deferred Retirement Option Plans

May 31, 2011

Earlier this month I visited Philadelphia for the Pension Research Council’s annual conference at Wharton. There, experts presented new research on how the economic downturn has hurt pension plans and retirees. But the most interesting pension debate in town that week took place behind closed doors at city hall, not within the ivy-covered walls of a preeminent business school. In those quiet deliberations, which will lead to public hearings next month, the dilemma facing local officials grappling with the city pension plan’s early retirement incentives became all too clear.

Like nearly every other US city, Philadelphia provides its employees with a generous pension that encourages them to retire early. Municipal employees who began their city careers at age 25 can begin collecting full pensions at age 60 equal to 72 percent of the average salary they earned in their top three years. However, their lifetime pension benefits fall if they work past 60 because they lose a month of benefits for every extra month they work. As I’ve complained before, these plans push many workers to retire early, depriving cities of experienced civil servants.

Philadelphia thought it found a way out of this dilemma back in 1999—a deferred retirement option plan. DROP lets employees approaching retirement freeze their pension benefits while they continue to work for up to four more years. The city deposits their pension benefits into special interest-bearing accounts and continues to pay their full salaries. Once they stop working, they collect their account balances as a lump sum (often totaling six figures) and begin receiving the same monthly pension they would have collected had they simply retired on cue.

DROP works—more city workers are delaying retirement. But the program is expensive. Because employees no longer have to forfeit a month of pension benefits when they work a month past retirement age, lifetime benefits have soared. One study puts the 10-year tab for the city at about $250 million, a hefty sum when revenue shortfalls are forcing service cuts. Not surprisingly, outraged voters are crying foul, accusing DROP participants of double dipping by collecting salaries at the same time they’re banking pensions.

Philadelphia’s city council vows to cut costs by reforming the program even though many of its members participate. Reducing the interest rate earned on DROP accounts and tightening eligibility requirements are ideas floated so far, but others want the program eliminated.

Stay tuned to find out what happens in Philadelphia. It may be time to rewrite the city’s traditional pension plan along with DROP. Or maybe it’s time to drop both. And expect the furor there as the city tries to square its need for experienced civil servants with a retirement plan that promotes early exits to spread to other metros soon.

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